Disputes loom over contractors’ status after IR35 reforms

Nearly two-thirds of contractors have been classified as “employed for tax purposes” since changes to the off-payroll working rules were introduced in April, research has found.

However, half of contractors plan to challenge their classification, suggesting the reforms are likely to spark a wave of disputes between businesses and contractors.

Since April 6, medium-sized and large businesses have been responsible for assessing the tax status of every contractor they hire. Before this, freelancers who billed for their services via limited companies assessed whether they were employed or self-employed for tax purposes under the off-payroll working rules — often known as IR35.

The changes drew the ire of businesses and contractors who mounted an unsuccessful campaign to stop the controversial measures being introduced. Rishi Sunak, the chancellor, responded to the criticism by promising HM Revenue & Customs would take a light-touch approach to the changes for the first year.

The survey of 1,850 contractors carried out in late April by Qdos, an advisory firm, has provided one of the first indications of how contractors and businesses responded to the changes.

It found 65 per cent of contractors had been assessed by their hiring companies as employed for tax purposes, or “inside IR35”, while 35 per cent had been assessed as self-employed for tax purposes.

Some 39 per cent planned to challenge firms over their classification while a further 11 per cent said they might challenge the decision. Meanwhile only 56 per cent of those assessed thought they had received an official determination of their status.

Seb Maley, chief executive of Qdos, which provides insurance and tax advice for contractors, said: “Reform has landed but that doesn’t mean it’s job done for businesses. Half of contractors might challenge their IR35 assessment, while a similar number aren’t sure if their client has provided them with a Status Determination Statement despite it being a legal requirement.

“Firms need to remember, preparing for IR35 reform was phase 1. Phase 2, which we have now entered, is ensuring compliance going forward.”

In a development that has raised concerns among tax experts, 64 per cent of contractors surveyed said they had been told they could work via a so-called “umbrella company”. These collect a worker’s earnings from their hiring firm or recruitment agency and then pay them after deducting tax and national insurance.

While many such businesses are legitimate, the unregulated industry of umbrella companies has come under increased scrutiny over fears some are exploiting workers and trapping them into tax avoidance.

HMRC recently published guidance on working through these companies to help contractors who may be using one for the first time. Nevertheless this week, the Low Incomes Tax Reform Group (LITRG), a charity, called for regulation of the industry, warning that “low-income workers continue to be at risk of working through non-compliant umbrella companies”.

Dave Chaplin, chief executive of IR35 Shield, a tax compliance adviser, said: “The push towards the use of unregulated umbrella companies is a concern, as the market is in desperate need of regulation and widespread reporting, particularly around the use of mini umbrella companies, indicates that it’s a market where all parties should tread with extreme caution.”

Andy Chamberlain, director of policy at the Association of Independent Professionals and the Self Employed, expressed concern over the surge in contractors joining umbrella companies since the reforms. He added the proportion of contractors being classified as inside IR35 was “an awful lot” — and suggested firms were classifying genuinely self-employed people as employed because they did not want to face investigations by the tax office.

Anita Monteith, senior policy adviser at the Institute of Chartered Accountants in England and Wales, said many businesses were likely to be confused by the rules or taking a “risk averse” approach to classification. She called on the government to analyse the effect of the reforms in a post-implementation review.

“There are still a lot of people who are rather confused about what they should do,” she said.

HMRC said: “The off-payroll working rules, known as IR35, ensure that individuals working like employees, but through their own limited company, are taxed like employees.

“The changes that took effect from April 6 do not introduce a new tax. They ensure that rules which have been in place since 2000 are applied correctly. The government consulted extensively on off-payroll working and is continuing to deliver an extensive education and support programme to help industry and contractors implement the reform.”